Special Advertising Section
Can Your Lender Pursue You for a
Deficiency?
Roger W. Hall
Donna Y. Ong
By Roger W. Hall and Donna Y. Ong, Buchalter Nemer
T
he Arizona Court of Appeals recently issued an opinion, Helvetica v. Pasquan, that might affect you if your home is foreclosed. Under Arizona’s anti-deficiency laws, which generally apply to residential properties, a lender cannot pursue you for a deficiency if the property is foreclosed through a trustee’s sale or the loan was used to purchase your home (a “purchase-money” obligation). But a lender can pursue you for a deficiency on a non-purchase-money obligation—but only if your home is foreclosed through a judicial foreclosure, and not a trustee’s sale. A deficiency is the difference between the loan amount and the value of the property.
Background
A husband and wife (the borrowers) purchased a house with $335,000 cash and a $600,000 loan from a mortgage company. The loan was secured by a deed of trust, commonly called a mortgage, on the property. Later, the borrowers obtained a second loan for $1.6 million from their bank, which was used to pay off the first loan, demolish the existing house and build a larger house on the same lot. The bank loan was secured by a new deed of trust on the property. The borrowers later obtained two more loans from the bank, which were also used for construction costs, according to the husband. Two years later, the borrowers refinanced the second loan with a $3.4 million loan from a third lender (the “lender”), which was secured by a new deed of trust against the property. The proceeds from the third loan were used as follows: • $2.1 million to pay off the bank loans. • $250,000 to pay off a loan from a family member. • $692,214 for closing costs, points/interest/reserves, and to pay off some credits cards used for construction. Approximately $357,786 was “cash out” to the borrowers. According to the husband, $228,000 was used for interest payments on the new loan, and the remaining approximately $129,786 was used for landscaping, maintenance, etc. The borrowers defaulted, and the lender filed a lawsuit for judicial foreclosure and for breach of contract. (The lender filed a foreclosure lawsuit in court, instead of foreclosing through a trustee’s sale.) The lender successfully foreclosed on the property and obtained a judgment against the borrowers for $3.6 million on the breach of contract claim. At the sheriff’s sale of the property, the lender bought the property with a credit bid of $400,000. The trial court granted a deficiency judgment against the borrowers of $1.9 million. The husband appealed to the Arizona Court of Appeals. (The borrowers had since divorced.)
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The Court of Appeals Decision
The primary issue before the Court of Appeals was whether the third loan was a “purchase-money” loan. That finding would determine whether the lender was entitled to a deficiency, since a deficiency is only available on non-purchase-money loans. The court stated that Arizona’s anti-deficiency statutes were intended to “protect consumers from financial ruin,” and eliminate hardships resulting to consumers who purchase a home but do not understand that they would be putting assets, other than the home itself, at risk in the event of a default and a judgment. The lender’s position was that since its loan was a refinancing loan, it was no longer a “purchase-money” loan. The husband argued that the second set of loans were construction loans and therefore “purchase money” in nature. He further argued that because the third loan refinanced an existing purchase-money loan, it was also a purchase-money loan. The court agreed with the husband, and held that when a purchasemoney loan is refinanced, it retains its nature as a purchase-money obligation. Those amounts were therefore exempt from execution under Arizona’s anti-deficiency statutes. The court further held that it did not matter whether the loan proceeds were used to purchase an existing dwelling or used for construction of a dwelling, the loan was still a purchase-money loan. Importantly, the court also held that only those amounts actually used to pay off the purchase-money loan or used for construction constituted “purchase money,” and thus received anti-deficiency protection. Any loan proceeds not used for those purposes were not “purchase money” and not protected under the anti-deficiency statutes. The lesson from this case: If you obtain loans that are only partially purchase money in nature—for example, if you refinance your house and take “cash out,” like many people did during the real estate boom—and if your lender forecloses judicially and not by a trustee’s sale, you may be liable for part of your loan in a deficiency action. Donna Y. Ong is a shareholder in the firm’s Real Estate and Bank and Finance Practice Groups in Scottsdale. She focuses her practice on commercial real estate transactions, leasing and lending, asset-based lending, and commercial banking and finance. Contact: 480-383-1813; dyong@buchalter.com. Roger W. Hall is Of Counsel and Administrative Chair of the firm’s Litigation Practice Group in Scottsdale. He has a multifaceted legal background, including experience in general commercial litigation and appeals; lender litigation and appeals; contract litigation, negotiation, and drafting; education; employment; bankruptcy; and First Amendment law. Contact: 480-383-1845; rhall@buchalter.com.